The Business Side: Deciding to lease or purchase
Not long ago, I began studying these options because my wife wanted a new vehicle. She had leased vehicles in the past, and when the lease period was up on her Honda, she decided to pay the residual amount due on the vehicle to become the owner. During this process, I researched the principles of leasing and purchasing--which apply to surveying equipment as well as to automobiles. So, among other resources for this article, I used “The Lease Guide: The Automotive Consumer’s Guide to Smart Leasing.” Ultimately, the answer to the question “Should I lease or buy?” is not simple. The answer is: “It depends.”
How is Leasing Different from Buying?When you buy, you pay for the entire cost of the item. Most of us in business pay this over time with a loan. For a loan, you typically make a down payment, pay sales tax and pay an interest rate determined by the loan company. Then you make monthly payments over the agreed upon time of the loan. A loan over a longer period of time results in more interest to be paid.
When you lease, you only pay for a portion of the equipment’s cost, which is the part that you “use up” during the time you have the equipment. Sometimes you have the options of not making a down payment, not paying any sales tax or paying tax only on the part you use, or paying a money factor that is similar to the interest rate on a loan. You may also pay extra fees and/or a security deposit that is not charged for a purchase. You make your first lease payment at the time you sign the agreement.
Loan payments are made up of two different parts: a principal charge and a finance charge. The finance charge is the interest you pay on the use of the money in the loan period, while the principal charge pays down the equipment purchase price.
Lease payments are also made up of two different parts. The depreciation charge compensates the leasing company for the portion of the equipment’s value that is lost during the lease. The finance charge is interest on the money the lease company has tied up in the equipment during the lease.
Equity−the remainder of the equipment’s value at the end of the payments−is an important consideration when buying or leasing. In buying, equity is the value of the equipment when paid in full. In leasing, equity is the value (usually set at the beginning of the lease) known as the residual that, in most leases, is the amount of money the lessee pays if he or she wants to purchase the equipment. The main difference between a lease and a loan is that at the end of the payments on a loan, the item automatically becomes the property of the buyer without a residual payment.
Why Consider a Lease?When deciding whether to lease or purchase, you should explore the following questions.
1. Is having new equipment every two or three years (without major repair risks) more important than long-term cost?
2. Are long-term cost savings more important than a lower monthly payment?
3. Is ownership more important than a low up-front cost with no down payment?
4. Do you only need the equipment for a short period of time (e.g., the life of a contract) before turning it in to the lease company?
Your answers to these questions should provide good guidelines for the financing option that will suit you best. Leasing equipment can be an attractive alternative for a variety of reasons. Here are some reasons I have adapted for surveyors from “The Leasing Guide”:
• Lower Monthly Payments. Because you are paying only for the portion of the equipment you use, you have lower monthly payments.
• More Equipment More Often. Since your payments are lower, you’ll be able to get more equipment for the same monthly money depending on the terms of your lease.
• Fewer Maintenance Costs. Because most equipment is leased for the short term, the manufacturer’s warranty coverage is still in effect and covers any problems with the equipment.
• Poor Credit, and Upfront Cash Outlay. Many who would not qualify for a loan can still lease because they are only renting the use of the equipment. Also, most leases require a small upfront payment that is attractive to those with cash-flow problems.
• Lower Tax Bite. Most lease payments are a complete tax write-off for companies. You will only pay sales tax on the lease portion of the total equipment price.
• Hassle-free Turn In. If you plan to turn in the equipment at the end of the lease and walk away (called a closed-end lease), you do not have the hassle of selling or trading in a purchased piece of equipment.
There is a downside to leasing that I caution you about. It is just as difficult to walk away from a lease contract as it is to get out of paying a loan. In most cases, you need to pay the remaining payments to break a lease. It is not as simple as taking the item back to the leasing company and walking away.
Comparing CostsWhen making decisions about equipment financing, it is important to perform a thorough analysis of the costs. The following summaries are again adapted for surveyors from “The Leasing Guide.”
The short-term (one to two years) monthly cost of leasing is always significantly less than the cost of buying. For the same equipment, same price, same term and same down payment, the cost of leasing will always be less than a purchase in the short term. This is because of the residual value you are not buying in your lease. Remember, you are only paying rent for the use of the item. (This is one of the reasons leasing is very popular with high-priced automobiles−the residual is still very high at the end of the lease.) This makes the lease payment the same or lower than buying a lower-priced piece of equipment with a loan.
A middle-term lease is about the same cost as buying assuming the buyer with a loan sells the equipment at the end of the lease. The overall cost for a middle-term lease/loan of about three to four years is approximately the same−again assuming the buyer with a loan sells the equipment. Comparisons show that the loan may be a little cheaper in this time frame because of more fees related to leasing. If you were to save the difference in the lower lease payment and sell the equipment purchased by a loan, the cost of leasing may be a little less.
Long-term leasing cost is always more than the cost of buying assuming the buyer keeps the equipment. At the end of a long-term lease of four to six years, the residual has to be paid on the lease to be able to keep the equipment. The buyer with a loan has value in the item at the end of the loan, while the leaser has to buy the residual value. The buyer can continue to use the item or sell it to recapture some value. If the lease was set up with little or no residual cost, the item probably should have been purchased with a loan to reduce cost.
Interest on Loans and LeasesMost readers should know that many disclosure laws dealing with loans exist, so anyone who loans money has to disclose the interest rate and other key facts of the transaction. Leases are a little different: Since you are only renting with a lease, the disclosure laws for loans do not apply. According to “The Lease Guide,” interest on most leases is based on a “money factor.” While this is similar to interest, it does have some differences and is not required to be shown on a lease contract. The bottom line is that it is more difficult to find the exact finance cost when leasing.
How to Lease or Buy WiselyWhen you get ready to lease or buy, always start out by getting the lowest cost quote on the piece of equipment. In many lease agreements, the lease company starts out with the manufacturer’s list price for the item, but it is better to structure a lease based on the lowest-cost quote. You may also contact a local credit union to find out the current rate for new equipment. Use this information to develop an estimate of the total cost to buy the item financed over a number of years.
To compare the loan cost to the lease cost, look at the total lease price and include the residual. In most cases, if you plan to pay out a lease over a longer term and purchase the residual at the lease termination, it would be cheaper to buy the item with a loan.
A lease may be the right ticket for your company if you need equipment for a short period of time, you do not plan to purchase the item and only want to pay for the used value. Be aware, however, that a trend today is to not list the original cost of an item--only the monthly payment. This is very common in the vehicle business. I can assure you that many leases are structured in such a way that they are not in the best interest of the person signing the lease. Good businesspeople watch their money very carefully. Are you one of these?
References for More Information•“The Lease Guide: The Automotive Consumer’s Guide to Smart Leasing,” www.LeaseGuide.com.
•“Business Owner’s Toolkit” www.toolkit.com.